filings.toolsItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K. This report contains forward-looking statements including, without limitation, statements regarding trends, seasonality and growth in, and drivers of, the markets we sell into, our strategic direction, our future effective tax rate and tax valuation allowance, earnings from our foreign subsidiaries, lease and site service income from Keysight, the impact of foreign currency movements on our performance, our hedging programs, indemnification, new product and service introductions, the ability of our products to meet market needs, adoption of our products, changes to our manufacturing processes, the use of contract manufacturers and out sourcing and third-party package delivery services, source and supply of materials used in our products, the impact of local government regulations on our ability to pay vendors or conduct operations, our liquidity position, our ability to generate cash from operations, growth in our businesses, our investments, including in research and development, the potential impact of adopting new accounting pronouncements, our financial results, our operating margin, our sales, our purchase commitments, our capital expenditures, our contributions to our pension plans and other defined benefit plans, our strategic initiatives, our cost-control activities and other cost saving initiatives, uncertainties relating to Food and Drug Administration ("FDA") and other regulatory approvals, the integration of our acquisitions and other transactions, impairment of goodwill and other intangible assets, write-down of investment values or loans and convertible notes, our stock repurchase program, our declared dividends, and the existence of economic instability, that involve risks and uncertainties. Our actual results could differ materially from the results contemplated by these forward-looking statements due to various factors, including those discussed in Part I Item 1A and elsewhere in this Form 10-K.
Overview and Executive Summary
Agilent Technologies Inc. ("we", "Agilent" or the "company"), incorporated in Delaware in May 1999, is a global leader in life sciences, diagnostics and applied chemical markets, providing application focused solutions that includes instruments, software, services and consumables for the entire laboratory workflow.
In November 2015, we completed the acquisition of Seahorse Bioscience ("Seahorse"), a leader in providing instruments and assay kits for measuring cell metabolism and bioenergetics for $242 million in cash. Seahorse's technology enables researchers to better understand cell health, function and signaling, and how the cell may be impacted by the introduction of a specific drug, by providing real-time kinetics to unlock essential cellular bioenergetics data. The financial results of Seahorse have been included within Agilent's consolidated financial statements from November 1, 2015.
On March 2, 2016, Agilent made a preferred stock investment in Lasergen for $80 million. Agilent’s initial ownership stake was 48 percent and we have also joined the board of Lasergen and signed a collaboration agreement. We have the option to acquire all of the remaining shares of Lasergen until March 2, 2018, for additional consideration of $105 million. Lasergen is a Variable Interest Entity (“VIE”), however, we do not consolidate the entity in our financial statements because we do not have the power to direct the activities of the VIE that most significantly impact the VIE's economic performance nor are we the primary beneficiary. Because of the nature of the preferred stock of Lasergen that we own, we account for this investment under the cost method.
On August 1, 2016 we completed the acquisition of substantially all of the assets of iLab Solutions LLC ("iLab"), a cloud-based solutions provider for core laboratory management. iLab's offerings enables customers to easily and accurately book time in shared facilities, to bill and invoice for projects, to manage studies, to generate reports and business intelligence, and to schedule instrument reservations across multiple projects. The purchase price was $26 million in cash. The financial results of iLab have been included within Agilent's consolidated financial statements from August 1, 2016.
Agilent's net revenue of $4,202 million in 2016 increased 4 percent when compared to 2015. Foreign currency movements for 2016 had an unfavorable impact of approximately 2 percentage points compared to 2015. Agilent's net revenue of $4,038 million was flat in 2015 when compared to 2014.
The life sciences and applied markets business brings together Agilent's analytical laboratory instrumentation and informatics. Revenue increased 1 percent in 2016 when compared to 2015. Foreign currency movements had an unfavorable impact of approximately 2 percentage points in 2016 when compared to 2015. For the year ended October 31, 2016 and excluding the impact of foreign currency movements, acquisitions and the NMR business our performance within the life sciences market continued to show strong revenue growth from the pharmaceutical and biotechnology markets. Within the applied markets, and excluding the impact of foreign currency movements and the NMR business, there was strong growth in both the environmental and food markets, but revenue from sales to other applied markets was weak with a decline in revenue from sales to the chemical and energy markets. Revenue decreased 2 percent in 2015 when compared to 2014. For the year ended October 31, 2015 and
excluding the impact of currency movements and the NMR business, our performance within the life sciences business showed consistent revenue growth from sales to the pharmaceutical and biotechnology market partially offset by a decrease in the revenue generated from sales to the life sciences research market. Within applied markets and excluding the impact of currency movements and the NMR business, there was weakness in the chemical and energy markets in the year ended October 31, 2015 when compared to the prior year.
The diagnostics and genomics business includes genomics, nucleic acid contract manufacturing and the pathology, companion diagnostics and reagent partnership businesses. Revenue increased 7 percent in 2016 when compared to 2015. Foreign currency movements had an unfavorable impact of approximately 1 percentage points in 2016 when compared to 2015. Excluding the impact of foreign currency movements and acquisitions, growth in revenue from sales to the diagnostics and clinical markets continued to be strong, led by our companion diagnostics and genomics businesses in the year ended October 31, 2016 when compared to the prior year. Revenue was flat in 2015 when compared to 2014. Excluding foreign currency movements, our growth in revenue from sales to the diagnostics and clinical markets was strong in the year ended October 31, 2015 when compared to the prior year.
The Agilent CrossLab business combines our analytical laboratory services and consumables business. Revenue increased 7 percent in 2016 when compared to 2015. Foreign currency movements had an unfavorable impact of approximately 2 percentage points in 2016 when compared to 2015. Excluding the impact of foreign currency movements and acquisitions, there was growth in sales to all key markets. The pharmaceutical and biotechnology markets led all the markets in revenue and revenue growth along with very strong revenue growth from the food markets. In addition, we saw moderate growth from the environmental market and modest revenue growth from the chemical and energy markets. Revenue increased 2 percent in 2015 when compared to 2014. Excluding the impact of foreign currency movements there was growth in sales to all key end markets, in particular, the pharmaceutical and biotechnology market in the year ended October 31, 2015 when compared to the prior year. Within the applied markets revenue in chemical and energy end markets were slower but still reported growth when adjusted for currency movements.
Net income from continuing operations was $462 million in 2016 compared to net income from continuing operations of $438 million and $232 million in 2015 and 2014, respectively. As of October 31, 2016 and 2015 we had cash and cash equivalents balances of $2,289 million and $2,003 million, respectively.
On November 22, 2013 we announced that our board of directors had authorized a share repurchase program. The existing program is designed to reduce or eliminate dilution resulting from issuance of stock under the company's employee equity incentive programs to target maintaining a weighted average share count of approximately 335 million diluted shares. For the years ended October 31, 2016, 2015 and 2014 we repurchased 2.4 million shares for $98 million, 6 million shares for $267 million and 4 million shares for $200 million, respectively. All such shares and related costs are held as treasury stock and accounted for using the cost method.
On May 28, 2015 we announced that our board of directors had approved a new share repurchase program (the "2015 repurchase program"). The 2015 share repurchase program authorizes the purchase of up to $1.14 billion of our common stock through and including November 1, 2018. The 2015 repurchase program does not require the company to acquire a specific number of shares and may be suspended or discontinued at any time. During the year ended October 31, 2016, upon the completion of our previous repurchase program, we repurchased approximately 8.3 million shares for $336 million under this authorization. All such shares and related costs are held as treasury stock and accounted for using the cost method.
For the years ended October 31, 2016, 2015 and 2014 cash dividends of $150 million, $133 million and $176 million were paid on the company's outstanding common stock, respectively. On November 16, 2016, we declared a quarterly dividend of $0.132 per share of common stock, or approximately $43 million which will be paid on January 25, 2017 to shareholders of record as of the close of business on January 3, 2017. The timing and amounts of any future dividends are subject to determination and approval by our board of directors.
Looking forward, we expect to continue to focus on the growth of the operating margin in our businesses by simplifying our operations, differentiating product solutions and improving our customer's experience. We anticipate returning a significant proportion of our cash flow to shareholders through our dividend and share repurchase programs. End market growth outlook in today's uncertain political and economic environment is unpredictable and challenging. However, we expect continued strength in the pharmaceutical markets and solid growth in the food and environmental markets but we remain uncertain about the growth in the chemical and energy markets. The unfavorable effects of changes in foreign currency exchange rates has decreased revenue by approximately 2 percentage points for the year ended October 31, 2016. Costs and expenses, incurred in local currency, were subject to the favorable effects due to changes in foreign currency exchange rates reducing our overall net exposure. The impact of foreign currency exchange rates movements can be positive or negative in any period and is calculated by applying the prior period foreign currency exchange rates to the current year period. We anticipate that changes in foreign currency exchange rates
will continue to have an unfavorable impact on our performance for the near future.
Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. Management bases its estimates on historical experience and various other assumptions believed to be reasonable. Although these estimates are based on management's best knowledge of current events and actions that may impact the company in the future, actual results may be different from the estimates. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used or changes in the accounting estimate that are reasonably likely to occur could materially change the financial statements. Our critical accounting policies are those that affect our financial statements materially and involve difficult, subjective or complex judgments by management. Those policies are revenue recognition, inventory valuation, share-based compensation, retirement and post-retirement plan assumptions, valuation of goodwill and purchased intangible assets and accounting for income taxes.
Revenue recognition. We enter into agreements to sell products (hardware or software), services, and other arrangements (multiple element arrangements) that include combinations of products and services. Revenue from product sales, net of trade discounts and allowances, is recognized provided that persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed or determinable, and collectability is reasonably assured. Delivery is considered to have occurred when title and risk of loss have transferred to the customer. Revenue is reduced for estimated product returns, when appropriate. For sales that include customer-specified acceptance criteria, revenue is recognized after the acceptance criteria have been met. For products that include installation, if the installation meets the criteria to be considered a separate element, product revenue is recognized upon delivery, and recognition of installation revenue occurs when the installation is complete. Otherwise, neither the product nor the installation revenue is recognized until the installation is complete. Revenue from services is deferred and recognized over the contractual period or as services are rendered and accepted by the customer. We allocate revenue to each element in our multiple-element arrangements based upon their relative selling prices. We determine the selling price for each deliverable based on a selling price hierarchy. The selling price for a deliverable is based on our vendor specific objective evidence (VSOE) if available, third-party evidence (TPE) if VSOE is not available, or estimated selling price (ESP) if neither VSOE nor TPE is available. Revenue from the sale of software products that are not required to deliver the tangible product's essential functionality are accounted for under software revenue recognition rules. Revenue allocated to each element is then recognized when the basic revenue recognition criteria for that element have been met. The amount of product revenue recognized is affected by our judgments as to whether an arrangement includes multiple elements.
We use VSOE of selling price in the selling price allocation in all instances where it exists. VSOE of selling price for products and services is determined when a substantial majority of the selling prices fall within a reasonable range when sold separately. TPE of selling price can be established by evaluating largely interchangeable competitor products or services in standalone sales to similarly situated customers. As our products contain a significant element of proprietary technology and the solution offered differs substantially from that of competitors, it is difficult to obtain the reliable standalone competitive pricing necessary to establish TPE. ESP represents the best estimate of the price at which we would transact a sale if the product or service were sold on a standalone basis. We determine ESP for a product or service by using historical selling prices which reflect multiple factors including, but not limited to customer type, geography, market conditions, competitive landscape, gross margin objectives and pricing practices. The determination of ESP is made through consultation with and approval by management. We may modify or develop new pricing practices and strategies in the future. As these pricing strategies evolve changes may occur in ESP. The aforementioned factors may result in a different allocation of revenue to the deliverables in multiple element arrangements, which may change the pattern and timing of revenue recognition for these elements but will not change the total revenue recognized for the arrangement.
Inventory valuation. We assess the valuation of our inventory on a periodic basis and make adjustments to the value for estimated excess and obsolete inventory based upon estimates about future demand and actual usage. Such estimates are difficult to make under most economic conditions. The excess balance determined by this analysis becomes the basis for our excess inventory charge. Our excess inventory review process includes analysis of sales forecasts, managing product rollovers and working with manufacturing to maximize recovery of excess inventory. If actual market conditions are less favorable than those projected by management, additional write-downs may be required. If actual market conditions are more favorable than anticipated, inventory previously written down may be sold to customers, resulting in lower cost of sales and higher income from operations than expected in that period. In the fourth quarter of 2014, Agilent announced it is exiting the NMR business, and as a result, recorded an excess inventory charge of $30 million. For the year ended October 31, 2015 and 2016 additional excess inventory charges were recorded in respect of the exiting of the NMR business of $4 million and $2 million, respectively.
Share-based compensation. We account for share-based awards in accordance with the authoritative guidance. Under the authoritative guidance, share-based compensation expense is primarily based on estimated grant date fair value and is recognized on a straight line basis. The fair value of share-based awards for employee stock option awards was estimated using the Black-Scholes option pricing model. No stock options were granted in 2016. Shares granted under the Long-Term Performance Program based on Total Shareholders Return ("LTPP-TSR") were valued using the Monte Carlo simulation model. The estimated fair value of restricted stock unit awards and LTPP based on Operating Margin (“LTPP-OM”) is determined based on the market price of Agilent's common stock on the date of grant adjusted for expected dividend yield. The compensation cost for LTPP (OM) reflects the cost of awards that are probable to vest at the end of the performance period. The Employee Stock Purchase Plan ("ESPP") allows eligible employees to purchase shares of our common stock at 85 percent of the fair market value at the purchase date. All awards granted in 2016 to our senior management employees have a one year post-vest holding restriction and the value of these awards are adjusted for this.
Both the Black-Scholes and Monte Carlo simulation fair value models require the use of highly subjective and complex assumptions, including the option's expected life and the price volatility of the underlying stock. No options were granted in 2016. Due to the separation of Keysight on November 1, 2014, expected volatility for grants of options in 2015 was based on a 5.5 year average historical stock price volatility of a group of our peer companies. We believe our historical volatility prior to the separation of Keysight is no longer relevant. In developing our estimated life of our employee stock options of 5.8 years for 2014, we considered the historical option exercise behavior of our executive employees who were granted the majority of the options in the annual grants, which we believed was representative of future behavior. See Note 4, "Share-based Compensation," to the consolidated financial statements for more information. For the grants awarded under the 2009 stock plan after November 1, 2010, we increased the period available to retirement eligible employees to exercise their options from three years at retirement date to the full contractual term of ten years.
The assumptions used in calculating the fair value of share-based awards represent our best estimates, but these estimates involve inherent uncertainties and the application of management judgment. Although we believe the assumptions and estimates we have made are reasonable and appropriate, changes in assumptions could materially impact our reported financial results.
In the third quarter of fiscal year 2016, the company elected to early adopt new guidance that changes the accounting for certain aspects of share-based payments to employees. For additional details related to the new guidance see Note 2, "New Accounting Pronouncements."
Retirement and post-retirement benefit plan assumptions. Retirement and post-retirement benefit plan costs are a significant cost of doing business. They represent obligations that will ultimately be settled sometime in the future and therefore are subject to estimation. Pension accounting is intended to reflect the recognition of future benefit costs over the employees' average expected future service to Agilent based on the terms of the plans and investment and funding decisions. To estimate the impact of these future payments and our decisions concerning funding of these obligations, we are required to make assumptions using actuarial concepts within the framework of accounting principles generally accepted in the U.S. Two critical assumptions are the discount rate and the expected long-term return on plan assets. Other important assumptions include, expected future salary increases, expected future increases to benefit payments, expected retirement dates, employee turnover, retiree mortality rates, and portfolio composition. We evaluate these assumptions at least annually.
The discount rate is used to determine the present value of future benefit payments at the measurement date - October 31 for both U.S. and non-U.S. plans. For 2015 and 2016, the U.S. discount rates were based on the results of matching expected plan benefit payments with cash flows from a hypothetically constructed bond portfolio. In 2016, discount rates for the U.S. Plans decreased 75 basis points from the previous year. For 2016 and 2015, the discount rate for non-U.S. plans was generally based on published rates for high quality corporate bonds and in 2016, decreased 60 basis points to 110 basis points from the previous year. If we changed our discount rate by 1 percent, the impact would be less than $1 million on U.S. pension expense and $16 million on non-U.S. pension expense. Lower discount rates increase present values of the pension benefit obligation and subsequent year pension expense; higher discount rates decrease present values of the pension benefit obligation and subsequent year pension expense.
The company uses alternate methods of amortization as allowed by the authoritative guidance which amortizes the actuarial gains and losses on a consistent basis for the years presented. For U.S. Plans, gains and losses are amortized over the average future lifetime of participants using the corridor method. For most Non-U.S. Plans and U.S. Post-Retirement Benefit Plans, gains and losses are amortized using a separate layer for each year's gains and losses. The expected long-term return on plan assets is estimated using current and expected asset allocations as well as historical and expected returns. Plan assets are valued at fair value. If we changed our estimated return on assets by 1 percent, the impact would be $4 million on U.S. pension expense and $7 million on non-U.S. pension expense. For 2016, actual return on assets was below expectations which, along with contributions during the year, increased next year’s pension cost as well as resulting in a degradation of the funded status at year end. The net
periodic pension and post-retirement benefit costs recorded in continuing operations were $3 million in 2016, $26 million in 2015 and $15 million in 2014. The year ended October 31, 2016, included a $16 million gain on curtailment and settlement.
Goodwill and Purchased Intangible Assets. Under the authoritative guidance we have the option to perform a qualitative assessment to determine whether further impairment testing is necessary. The accounting standard gives an entity the option to first assess qualitative factors to determine whether performing the two-step test is necessary. If an entity believes, as a result of its qualitative assessment, that it is more-likely-than-not (i.e. greater than 50% chance) that the fair value of a reporting unit is less than its carrying amount, the quantitative impairment test will be required. Otherwise, no further testing will be required.
The guidance includes examples of events and circumstances that might indicate that a reporting unit's fair value is less than its carrying amount. These include macro-economic conditions such as deterioration in the entity's operating environment or industry or market considerations; entity-specific events such as increasing costs, declining financial performance, or loss of key personnel; or other events such as an expectation that a reporting unit will be sold or a sustained decrease in the stock price on either an absolute basis or relative to peers.
If it is determined, as a result of the qualitative assessment, that it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount, the provisions of authoritative guidance require that we perform a two-step impairment test on goodwill. In the first step, we compare the fair value of each reporting unit to its carrying value. The second step (if necessary) measures the amount of impairment by applying fair-value-based tests to the individual assets and liabilities within each reporting unit. As defined in the authoritative guidance, a reporting unit is an operating segment, or one level below an operating segment. We aggregate components of an operating segment that have similar economic characteristics into our reporting units.
In fiscal year 2016, we assessed goodwill impairment for our three reporting units which consisted of three segments: life sciences and applied markets, diagnostics and genomics and Agilent CrossLab. We performed a qualitative test for goodwill impairment of the three reporting units, as of September 30, 2016. Based on the results of our qualitative testing, we believe that it is more-likely-than-not that the fair value of these reporting units are greater than their respective carrying values. Each quarter we review the events and circumstances to determine if goodwill impairment is indicated. There was no impairment of goodwill during the years ended October 31, 2016, 2015 and 2014.
Purchased intangible assets consist primarily of acquired developed technologies, proprietary know-how, trademarks, and customer relationships and are amortized using the best estimate of the asset's useful life that reflect the pattern in which the economic benefits are consumed or used up or a straight-line method ranging from 6 months to 15 years. In-process research and development ("IPR&D") is initially capitalized at fair value as an intangible asset with an indefinite life and assessed for impairment thereafter. When the IPR&D project is complete, it is reclassified as an amortizable purchased intangible asset and is amortized over its estimated useful life. If an IPR&D project is abandoned, Agilent will record a charge for the value of the related intangible asset to Agilent's consolidated statement of operations in the period it is abandoned.
Agilent's indefinite-lived intangible assets are IPR&D intangible assets. The accounting guidance allows a qualitative approach for testing indefinite-lived intangible assets for impairment, similar to the issued impairment testing guidance for goodwill and allows the option to first assess qualitative factors (events and circumstances) that could have affected the significant inputs used in determining the fair value of the indefinite-lived intangible asset to determine whether it is more-likely-than-not (i.e. greater than 50% chance) that the indefinite-lived intangible asset is impaired. An organization may choose to bypass the qualitative assessment for any indefinite-lived intangible asset in any period and proceed directly to calculating its fair value. We performed a qualitative test for impairment of indefinite-lived intangible assets as of September 30, 2016. Based on the results of our qualitative testing, we believe that it is more-likely-than-not that the fair value of these indefinite-lived intangible assets is greater than their respective carrying values. Each quarter we review the events and circumstances to determine if impairment of indefinite-lived intangible asset is indicated. In the years ended October 31, 2016, 2015 and 2014, we recorded an impairment of $4 million, $3 million and $4 million, respectively, due to the cancellation of certain IPR&D projects. In addition, in the year ended October 31, 2014, we also recorded $12 million of impairment of other intangibles due to the exit of our NMR business.
Accounting for income taxes. We must make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of tax credits, benefits and deductions, and in the calculation of certain tax assets and liabilities which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes, as well as interest and penalties related to uncertain tax positions. Significant changes to these estimates may result in an increase or decrease to our tax provision in a subsequent period.
Significant management judgment is also required in determining whether deferred tax assets will be realized in full or in part. When it is more-likely-than-not that all or some portion of specific deferred tax assets such as net operating losses or foreign tax credit carryforwards will not be realized, a valuation allowance must be established for the amount of the deferred tax assets
that cannot be realized. We consider all available positive and negative evidence on a jurisdiction-by-jurisdiction basis when assessing whether it is more likely than not that deferred tax assets are recoverable. We consider evidence such as our past operating results, the existence of losses in recent years and our forecast of future taxable income. In the fourth quarter of fiscal 2012 we released the valuation allowance for the majority of our U.S. deferred tax assets. At October 31, 2016, we continue to recognize a valuation allowance for certain U.S. and U.S state and foreign deferred tax assets. We intend to maintain a valuation allowance in these jurisdictions until sufficient positive evidence exists to support its reversal.
We have not provided for all U.S. federal income and foreign withholding taxes on the undistributed earnings of some of our foreign subsidiaries because we intend to reinvest such earnings indefinitely. Should we decide to remit this income to the U.S. in a future period, our provision for income taxes will increase materially in that period.
The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax law and regulations in a multitude of jurisdictions. Although the guidance on the accounting for uncertainty in income taxes prescribes the use of a recognition and measurement model, the determination of whether an uncertain tax position has met those thresholds will continue to require significant judgment by management. In accordance with the guidance on the accounting for uncertainty in income taxes, for all U.S. and other tax jurisdictions, we recognize potential liabilities for anticipated tax audit issues based on our estimate of whether, and the extent to which, additional taxes and interest will be due. The ultimate resolution of tax uncertainties may differ from what is currently estimated, which could result in a material impact on income tax expense. If our estimate of income tax liabilities proves to be less than the ultimate assessment, a further charge to expense would be required. If events occur and the payment of these amounts ultimately proves to be unnecessary, the reversal of the liabilities would result in tax benefits being recognized in the period when we determine the liabilities are no longer necessary. We include interest and penalties related to unrecognized tax benefits within the provision for income taxes on the consolidated statements of operations.
As a part of our accounting for business combinations, intangible assets are recognized at fair values and goodwill is measured as the excess of consideration transferred over the net estimated fair values of assets acquired. Impairment charges associated with goodwill are generally not tax deductible and will result in an increased effective income tax rate in the period that any impairment is recorded. Amortization expenses associated with acquired intangible assets are generally not tax deductible and therefore deferred tax liabilities have been recorded for non-deductible amortization expenses as a part of the accounting for business combinations.
Adoption of New Pronouncements
See Note 2, "New Accounting Pronouncements," to the consolidated financial statements for a description of new accounting pronouncements.
Foreign Currency
Our revenues, costs and expenses, and monetary assets and liabilities are exposed to changes in foreign currency exchange rates as a result of our global operating and financing activities. The unfavorable effects of changes in foreign currency exchange rates has decreased revenue by approximately 2 percentage points for the year ended October 31, 2016 and 6 percentage points for the year ended October 31, 2015. Costs and expenses, incurred in local currency, were subject to the favorable effects due to changes in foreign currency exchange rates for the years ended October 31, 2016 and 2015, reducing our overall net exposure. The impact of foreign currency exchange rates movements can be positive or negative in any period and is calculated by applying the prior period foreign currency exchange rates to the current year period. We hedge revenues, expenses and balance sheet exposures that are not denominated in the functional currencies of our subsidiaries on a short term and anticipated basis. We do experience some fluctuations within individual lines of the consolidated statement of operations and balance sheet because our hedging program is not designed to offset the currency movements in each category of revenues, expenses, monetary assets and liabilities. Our hedging program is designed to hedge currency movements on a relatively short-term basis (up to a rolling twelve-month period). Therefore, we are exposed to currency fluctuations over the longer term. To the extent that we are required to pay for all, or portions, of an acquisition price in foreign currencies, Agilent may enter into foreign exchange contracts to reduce the risk that currency movements will impact the U.S. dollar cost of the transaction.
Results from Operations
Net Revenue
| Years Ended October 31, | 2016 over 2015 % Change | 2015 over 2014% Change | |||||||||||||
| 2016 | 2015 | 2014 | |||||||||||||
| (in millions) | |||||||||||||||
| Net revenue: | |||||||||||||||
| Products | $ | 3,227 | $ | 3,146 | $ | 3,185 | 3% | (1)% | |||||||
| Services and other | $ | 975 | $ | 892 | $ | 863 | 9% | 4% | |||||||
| Total net revenue | $ | 4,202 | $ | 4,038 | $ | 4,048 | 4% | — |
| Years Ended October 31, | 2016 over 2015 Ppts Change | 2015 over 2014 Ppts Change | ||||||||||
| 2016 | 2015 | 2014 | ||||||||||
| % of total net revenue: | ||||||||||||
| Products | 77 | % | 78 | % | 79 | % | (1) ppt | (1) ppt | ||||
| Services and other | 23 | % | 22 | % | 21 | % | 1 ppt | 1 ppt | ||||
| Total | 100 | % | 100 | % | 100 | % |
Agilent's net revenue of $4,202 million in October 31, 2016 increased 4 percent when compared to 2015. Foreign currency movements for 2016 had an unfavorable impact of approximately 2 percentage points compared to 2015. Agilent's net revenue of $4,038 million was flat in 2015 when compared to 2014.
Services and other revenue includes revenue generated from servicing our installed base of products, warranty extensions and consulting including companion diagnostics. Services and other revenue increased 9 percent in 2016 as compared to 2015. The service and other revenue growth is impacted by a portion of the revenue being driven by the current and previously installed product base. Service and other revenue increased due to increased service contract repairs, compliance services and preventative maintenance, and strong companion diagnostics revenue. Services and other revenue increased 4 percent in 2015 as compared to 2014.
Net Revenue By Segment
| Years Ended October 31, | 2016 over 2015 % Change | 2015 over 2014% Change | |||||||||||||
| 2016 | 2015 | 2014 | |||||||||||||
| (in millions) | |||||||||||||||
| Net revenue by segment: | |||||||||||||||
| Life sciences and applied markets | $ | 2,073 | $ | 2,046 | $ | 2,078 | 1% | (2)% | |||||||
| Diagnostics and genomics | $ | 709 | $ | 662 | $ | 663 | 7% | — | |||||||
| Agilent CrossLab | $ | 1,420 | $ | 1,330 | $ | 1,307 | 7% | 2% | |||||||
| Total net revenue | $ | 4,202 | $ | 4,038 | $ | 4,048 | 4% | — |
The life sciences and applied markets business brings together Agilent's analytical laboratory instrumentation and informatics. Revenue increased 1 percent in 2016 when compared to 2015. Foreign currency movements had an unfavorable impact of approximately 2 percentage points in 2016 when compared to 2015. For the year ended October 31, 2016 and excluding the impact of foreign currency movements, acquisitions and the NMR business our performance within the life sciences market continued to show strong revenue growth from the pharmaceutical and biotechnology markets. Within the applied markets, and excluding the impact of foreign currency movements and the NMR business, there was strong growth in both the environmental and food markets, but revenue from sales to other applied markets was weak with a decline in revenue from sales to the chemical and energy markets. Revenue decreased 2 percent in 2015 when compared to 2014. For the year ended October 31, 2015 and excluding the impact of currency movements and the NMR business, our performance within the life sciences business showed consistent revenue growth from sales to the pharmaceutical and biotechnology market partially offset by a decrease in the revenue generated from sales to the life sciences research market. Within applied markets and excluding the impact of currency movements and the NMR business, there was weakness in the chemical and energy markets in the year ended October 31, 2015 when compared to the prior year.
The diagnostics and genomics business includes genomics, nucleic acid contract manufacturing and the pathology, companion diagnostics and reagent partnership businesses. Revenue increased 7 percent in 2016 when compared to 2015. Foreign currency movements had an unfavorable impact of approximately 1 percentage points in 2016 when compared to 2015. Excluding the impact of foreign currency movements and acquisitions, growth in revenue from sales to the diagnostics and clinical research markets continued to be strong, led by our companion diagnostics and genomics businesses in the year ended October 31, 2016 when compared to the prior year. Revenue was flat in 2015 when compared to 2014. Excluding foreign currency movements, our growth in revenue from sales to the diagnostics and clinical markets was strong in the year ended October 31, 2015 when compared to the prior year.
The Agilent CrossLab business combines our analytical laboratory services and consumables business. Revenue increased 7 percent in 2016 when compared to 2015. Foreign currency movements had an unfavorable impact of approximately 2 percentage points in 2016 when compared to 2015. Excluding the impact of foreign currency movements and acquisitions, there was growth in sales to all key markets. The phamaceutical and biotechnology markets led all the markets in revenue and revenue growth along with very strong revenue growth from the food markets. In addition, we saw moderate growth from the environmental market and modest revenue growth from the chemical and energy markets. Revenue increased 2 percent in 2015 when compared to 2014. Excluding the impact of foreign currency movements there was growth in sales to all key end markets, in particular, the pharmaceutical and biotechnology market in the year ended October 31, 2015 when compared to the prior year. Within the applied markets revenue in chemical and energy end markets were slower but still reported growth when adjusted for currency movements.
Costs and Expenses
| Years Ended October 31, | 2016 over 2015 Change | 2015 over 2014 Change | ||||||||||
| 2016 | 2015 | 2014 | ||||||||||
| Gross margin on products | 54.6 | % | 52.5 | % | 50.8 | % | 2 ppts | 2 ppts | ||||
| Gross margin on services and other | 44.5 | % | 43.8 | % | 41.6 | % | 1 ppt | 2 ppts | ||||
| Total gross margin | 52.3 | % | 50.5 | % | 48.8 | % | 2 ppts | 2 ppts | ||||
| Operating margin | 14.6 | % | 12.9 | % | 10.4 | % | 2 ppts | 3 ppts |
| (in millions) | |||||||||||||||
| Research and development | $ | 329 | $ | 330 | $ | 358 | — | (8)% | |||||||
| Selling, general and administrative | $ | 1,253 | $ | 1,189 | $ | 1,199 | 5% | (1)% |
Total gross margin for the year ended October 31, 2016 increased 2 percentage points when compared to last year. Increases in total gross margins for the year ended October 31, 2016 were as a result of the exit of the NMR business, several margin improvement initiatives, lower logistics costs, lower costs to address the now lifted FDA warning letter offset by increased wages and variable pay. Total gross margins for the year ended October 31, 2015 increased 2 percentage points when compared the prior year. Increases in total gross margins for the year ended October 31, 2015 were the result of lower intangible asset amortization, favorable product mix and improved manufacturing efficiencies partially offset by the impact of unfavorable currency movements and wage increases.
Total operating margin increased 2 percentage points for the year ended October 31, 2016, when compared to last year. Operating margins increased due to improvements in gross margin and the impact of an employee pension curtailment gain offset by the increased acquisition and integrations costs, the impairment charge for investment-related loans and increased wages and variable pay. Total operating margins increased 3 percentage points for the year ended October 31, 2015, when compared to last year. Operating margins improved due to increased gross margins and reduced expenses on lower revenue compared to last year.
Gross inventory charges, included in continuing operations, were $20 million in 2016, $30 million in 2015 and $46 million in 2014. Sales of previously written down inventory, included in continuing operations, were $9 million in 2016, $13 million in 2015 and $8 million in 2014.
Our research and development efforts focus on potential new products and product improvements covering a wide variety of technologies, none of which is individually significant to our operations. Our research seeks to improve on various technical competencies in software, systems and solutions, life sciences and diagnostics. In each of these research fields, we conduct research that is focused on specific product development for release in the short-term as well as other research that is intended to be the foundation for future products over a longer time-horizon. Most of our product development research is designed to improve products already in production, focus on major new product releases, and develop new product segments for the future. Due to
the breadth of research and development projects across all of our businesses, there are a number of drivers of this expense. We remain committed to invest significantly in research and development and have focused our development efforts on key strategic opportunities to align our business with available markets and position ourselves to capture market share.
Research and development expenses was relatively flat for the year ended October 31, 2016 when compared with last year. Research and development expenditures increased by a $4 million in-process research and development (IPR&D) impairment charge mostly offset by the impact of an employee pension curtailment gain. Research and development expenses decreased 8 percent for the year ended October 31, 2015 when compared with last year. R&D expenditure decreased due to the impact of foreign currency movements, savings from the exit from the NMR business and transformation initiatives, offset by wage increases.
Selling, general and administrative expenses increased 5 percent in 2016 compared to 2015. Selling, general and administrative expenses increased due to acquisition and integration costs related to recently acquired businesses, higher wages and variable pay and an impairment charge related to equity method investment loans offset by the impact of an employee pension curtailment gain. Selling, general and administrative expenses decreased 1 percent in 2015 compared to 2014. There were increases in expenditure mostly due to the impact of wage increases, higher commissions and costs associated with business improvement and transformation initiatives more than offset by favorable foreign currency movements and the decline in NMR expenses due to the exiting of that business together with a decrease in pre separation expenses related to the separation of Keysight.
Interest expense for the years ended October 31, 2016, 2015 and 2014 was $72 million, $66 million and $110 million, respectively, and relates to the interest charged on our senior notes and the amortization of the deferred loss recorded upon termination of the forward starting interest rate swap contracts offset by the amortization of deferred gains recorded upon termination of interest rate swap contracts. The decrease in interest expense in 2015 compared with 2014 is due to debt redemptions as part of the debt repositioning as a result of the separation of the Keysight business.
At October 31, 2016, our headcount was approximately 12,500 compared to 11,800 in 2015.
Other income (expense), net
For the year ended October 31, 2016 other income (expense), net includes an $18 million expense related to the impairment of an investment and $12 million of income in respect of the provision of certain site service costs to, and lease income from, Keysight. The costs associated with these services are reported within income from operations. Agilent expects to receive lease income and site service income from Keysight over the next 3-4 years of approximately $12 million per year. For the year ended October 31, 2015, other income (expense), net included $25 million of income in respect of the provision of certain IT and site service costs to, and lease income from, Keysight. For the year ended October 31, 2014 other income (expense) net, included a net loss on the early redemption of senior notes of $89 million.
Income Taxes
| Years Ended October 31, | |||||||||||
| 2016 | 2015 | 2014 | |||||||||
| (in millions) | |||||||||||
| Provision (benefit) for income taxes | $ | 82 | $ | 42 | $ | (3 | ) |
For 2016, the company’s effective tax rate from continuing operations was 15.1 percent. The income tax expense from continuing operations was $82 million. The income tax provision from continuing operations for the year ended October 31, 2016 included net discrete tax expense of $17 million. The net discrete tax expense for the year ended October 31, 2016, included $5 million of tax benefit for the extension of the U.S. research and development tax credit attributable to the company's prior fiscal year, $6 million of tax expense related to the curtailment gain recognized with respect to the U.S. retirement plan and Supplemental Benefits Plan, $18 million of tax expense related to the establishment of a valuation allowance on an equity method impairment that would generate a capital loss when realized, and a net $2 million of other discrete tax benefit. Included in the net $2 million discrete tax benefit are $9 million of out-of-period correcting tax expense entries recorded in the second and fourth quarters of the fiscal year of 2016 associated with German return-to-provision corrections. These are offset by an $11 million out-of-period tax benefit associated with an adjustment to the deferred tax liability for unremitted foreign earnings. The out-of-period corrections were determined to be immaterial to the previously issued and current period financial statements.
For 2015, the company's effective tax rate from continuing operations was 8.7 percent. The income tax expense from continuing operations was $42 million. The income tax benefit for the year ended October 31, 2015 included a net discrete benefit
of $55 million primarily due to the settlement of an Internal Revenue Service ("IRS") audit in the U.S. and the recognition of tax expense related to the repatriation of dividends.
For 2014, the company’s effective tax rate from continuing operations was (1.3) percent. The income tax benefit from continuing operations was $3 million. The income tax benefit for the year ended October 31, 2014 included a net discrete benefit of $33 million primarily due to the settlement of an Internal Revenue Service (“IRS”) audit in the U.S. and the recognition of tax expense related to the repatriation of dividends.
Agilent enjoys tax holidays in several different jurisdictions, most significantly in Singapore. The tax holidays provide lower rates of taxation on certain classes of income and require various thresholds of investments and employment or specific types of income in those jurisdictions. The tax holidays are due for renewal between 2018 and 2023. As a result of the incentives, the impact of the tax holidays decreased income taxes by $86 million, $65 million, and $27 million in 2016, 2015, and 2014, respectively. The benefit of the tax holidays on net income per share (diluted) was approximately $0.26, $0.19, and $0.08 in 2016, 2015 and 2014, respectively.
In accordance with the guidance on the accounting for uncertainty in income taxes, for all U.S. and other tax jurisdictions, we recognize potential liabilities for anticipated tax audit issues based on our estimate of whether, and the extent to which, additional taxes and interest will be due. If our estimate of income tax liabilities proves to be less than the ultimate assessment, a further charge to expense would be required. If events occur and the payment of these amounts ultimately proves to be unnecessary, the reversal of the liabilities would result in tax benefits being recognized in the period when we determine the liabilities are no longer necessary. We include interest and penalties related to unrecognized tax benefits within the provision for income taxes on the consolidated statements of operations.
On November 1, 2014, Agilent transferred deferred tax assets of $237 million, deferred tax liabilities of $37 million, current income tax payable of $40 million, and other long-term liabilities related to uncertain tax positions totaling $8 million to Keysight as part of its separation from Agilent. A current prepaid income tax asset of $19 million and long-term prepaid income tax asset of $3 million related to sales of intercompany assets was also transferred to Keysight upon separation from Agilent. In addition, for the year ended October 31, 2015, a $6 million return to provision adjustment for Keysight associated with bonus depreciation was recognized through retained earnings.
In the U.S., tax years remain open back to the year 2012 for federal income tax purposes and the year 2000 for significant states. On September 22, 2015, we reached an agreement with the Internal Revenue Service ("IRS") for the tax years 2008 through 2011. During the first quarter of 2016, we made a payment of approximately $9 million of tax plus interest as part of closing the exam. In 2015, we reclassified a portion of other long-term liabilities to other accrued liabilities related to uncertain tax positions of continuing operations that we expected to pay within the next twelve months. This amount was partially offset by a prepaid tax account of approximately $3 million that the IRS allowed as an offset to the $12 million in incremental taxes. The settlement resulted in the recognition, within the continuing operations, of previously unrecognized tax benefits of $119 million, offset by a tax liability on foreign distributions of approximately $99 million principally related to the repatriation of foreign earnings.
On January 29, 2014, we reached an agreement with the IRS for the tax years 2006 through 2007. The settlement resulted in the recognition, within the continuing operations, of previously unrecognized tax benefits of $111 million, offset by a tax liability on foreign distributions of approximately $75 million principally related to the repatriation of foreign earnings.
In other major jurisdictions where the company conducts business, the tax years generally remain open back to the year 2003. With these jurisdictions and the U.S., it is reasonably possible that there could be significant changes to our unrecognized tax benefits in the next twelve months due to either the expiration of a statute of limitation or a tax audit settlement which will be partially offset by an anticipated tax liability related to unremitted foreign earnings, where applicable. Given the number of years and numerous matters that remain subject to examination in various tax jurisdictions, management is unable to estimate the range of possible changes to the balance of our unrecognized tax benefits.
On July 27, 2015, the U.S. Tax Court issued an opinion in Altera Corp. v. Commissioner related to the treatment of stock-based compensation expense in an intercompany cost-sharing arrangement. A final decision was entered by the U.S. Tax Court on December 1, 2015. At this time, the U.S. Department of the Treasury has not withdrawn the requirement from its regulations to include stock-based compensation. The IRS notified the U.S. Court of Appeals for the Ninth Circuit on February 19, 2016 of its intent to appeal the Tax Court's decision in the case. We concluded that no adjustment to our consolidated financial statements is appropriate at this time due to the uncertainties with respect to the ultimate resolution of this case.
Segment Overview
Through October 31, 2016, we have three business segments comprised of the life sciences and applied markets business, diagnostics and genomics business and the Agilent CrossLab business.
Life Sciences and Applied Markets
Our life sciences and applied markets business provides application-focused solutions that include instruments and software that enable customers to identify, quantify and analyze the physical and biological properties of substances and products, as well as enable customers in the clinical and life sciences research areas to interrogate samples at the molecular level. Key product categories include: liquid chromatography ("LC") systems and components; liquid chromatography mass spectrometry ("LCMS") systems; gas chromatography ("GC") systems and components; gas chromatography mass spectrometry ("GCMS") systems; inductively coupled plasma mass spectrometry ("ICP-MS") instruments; atomic absorption ("AA") instruments; microwave plasma-atomic emission spectrometry (“MP-AES”) instruments; inductively coupled plasma optical emission spectrometry ("ICP-OES") instruments; cell analysis plate based assays; laboratory software and informatics systems; laboratory automation and robotic systems; dissolution testing; vacuum pumps and measurement technologies.
Net Revenue
| Years Ended October 31, | 2016 over 2015 Change | 2015 over 2014 Change | |||||||||||||
| 2016 | 2015 | 2014 | |||||||||||||
| (in millions) | |||||||||||||||
| Net revenue | $ | 2,073 | $ | 2,046 | $ | 2,078 | 1% | (2)% |
Life science and applied markets business revenue in 2016 increased 1 percent compared to 2015. Foreign currency movements for 2016 had an unfavorable impact of 2 percentage points on revenue growth when compared to the same period last year. Geographically, revenue declined 6 percent in the Americas with a 1 percentage point unfavorable currency impact. Revenue declined 8 percent in Europe with a 4 percentage point unfavorable currency impact. Revenue grew 7 percent in Japan with an 8 percentage point favorable currency impact. Revenue grew 14 percent in Asia Pacific excluding Japan with a 1 percentage point unfavorable currency impact. Strong growth in China led the geographic portfolio during 2016, and helped offset softness in the Americas and Europe. Liquid chromatography products revenue continued solid growth on strength in the pharmaceutical market. Revenue from mass spectrometry had instances of strength, particularly in China, which were offset by continued declines in revenue in the chemical and energy markets as well as diagnostic and clinical market declines in the Americas. Life science and applied markets business revenue in 2015 decreased 2 percent compared to 2014. During 2015 we exited the research products business, which reduced overall life sciences and applied markets growth by 2 percentage points. Product revenue results were otherwise solid across the rest of the product portfolio. Strength in the Americas and Europe pharmaceutical business were offset by softness in applied markets and life science research.
End market performance reflected mixed growth across markets in 2016. Pharmaceutical market growth continued to be robust in 2016 driven by continuing technology refresh programs. The growth led the way for life sciences and diagnostics markets, which were offset somewhat by lower diagnostic and clinical sales, notably in the US related to a slowdown in pain management related sales. Food and environmental markets, driven by strong sales in China, were areas of good growth in an otherwise weak applied market sector. Chemical and energy markets continued their declines throughout 2016 as oil prices remain low. Markets were also mixed for 2015 with pharmaceutical growth offset by delayed capital spending in life science research markets, and chemical and energy weakness from low oil prices.
Looking forward, we are optimistic about our growth opportunities in the life sciences and applied markets as our broad portfolio of products and solutions are well suited to address customer needs. We expect strong sales funnels given a number of significant new product introductions in the next few quarters as we continue to invest in expanding and improving our applications and solutions portfolio. We remain concerned about short term prospects in chemical and energy markets, but are confident in our product portfolio to address customer needs when the market does recover.
Gross Margin and Operating Margin
The following table shows the life sciences and applied markets business' margins, expenses and income from operations for 2016 versus 2015, and 2015 versus 2014.
| Years Ended October 31, | 2016 over 2015 Change | 2015 over 2014 Change | ||||||||||
| 2016 | 2015 | 2014 | ||||||||||
| Total gross margin | 58.6 | % | 56.2 | % | 55.8 | % | 2 ppts | — | ||||
| Operating margin | 20.7 | % | 18.6 | % | 17.7 | % | 2 ppts | 1 ppt |
| (in millions) | |||||||||||||||
| Research and development | $ | 195 | $ | 192 | $ | 215 | 2% | (10)% | |||||||
| Selling, general and administrative | $ | 590 | $ | 576 | $ | 576 | 2% | — | |||||||
| Income from operations | $ | 429 | $ | 380 | $ | 369 | 13% | 3% |
Gross margin increased 2 percentage points in 2016 compared to 2015. The exit of our research products division contributed 1 percentage point to gross margin improvement with the rest a combination of reduced warranty costs and improved efficiencies in logistics offset by wage increases and variable pay. Gross margins were flat in 2015 compared to 2014. Increases for wages and materials were largely offset by improvement in operational efficiencies.
Research and development expenses increased 2 percent in 2016 when compared to 2015. Acquisitions roughly offset savings from the research products division exit, with growth coming from wage increases, variable pay and targeted investments. Research and development expenses decreased 10 percent in 2015 when compared to 2014. Excluding NMR, 2015 research and development expenses were down 4 percent from 2014 impacted by our transformation initiatives.
Selling, general and administrative expenses increased 2 percent in 2016 compared to 2015. Acquisitions roughly offset savings from the research products division exit, with growth coming from wage increases and variable pay. Selling, general and administrative expenses were flat in 2015 compared to 2014. Excluding NMR, selling, general and administrative expenses grew 3 percent primarily due to dis-synergies in infrastructure costs from the separation of Keysight.
Operating margin increased 2 percentage points in 2016 compared to 2015. The exit of our research products division contributed 2 percentage point to operating margin improvement, with gross margin improvements from lower warranty and logistics costs making up the difference. Operating margins increased by 1 percentage point in 2015 compared to 2014. Expenses declined more than revenue to help with the improvement.
Income from Operations
Income from operations in 2016 increased by $49 million or 13 percent compared to 2015 on a revenue increase of $27 million. The exit of our research products division contributed roughly 40 percent of the improvement with revenue growth and improved gross margins making up the difference. Income from operations in 2015 increased by $11 million or 3 percent compared to 2014 on a revenue decrease of $32 million.
Diagnostics and Genomics
Our diagnostics and genomics business includes genomics, nucleic acid contract manufacturing and the pathology, companion diagnostics and reagent partnership businesses.
Our diagnostics and genomics business is comprised of five areas of activity providing solutions that include reagents, instruments, software and consumables, which enable customers in the clinical and life sciences research areas to interrogate samples at the cellular and molecular level. First, our genomics business includes arrays for DNA mutation detection, genotyping, gene copy number determination, identification of gene rearrangements, DNA methylation profiling, gene expression profiling, as well as next generation sequencing ("NGS") target enrichment and genetic data management and interpretation support software. Second, our nucleic acid solutions business provides equipment and expertise focused on production of synthesized oligonucleotides under pharmaceutical good manufacturing practices ("GMP") conditions for use as active pharmaceutical ingredients ("API") in an emerging class of drugs that utilize nucleic acid molecules for disease therapy. Next, our pathology solutions business is focused on product offerings to cancer diagnostics and anatomic pathology workflows. The broad portfolio of offerings includes immunohistochemistry (“IHC”), in situ hybridization (“ISH”), hematoxylin and eosin (“H&E”) staining and
special staining. We also collaborate with a number of major pharmaceutical companies to develop new potential pharmacodiagnostics, also known as companion diagnostics, which may be used to identify patients most likely to benefit from a specific targeted therapy. Finally, the reagent partnership business is a provider of reagents used for turbidimetry and flow cytometry.
Net Revenue
| Years Ended October 31, | 2016 over 2015 Change | 2015 over 2014 Change | |||||||||||||
| 2016 | 2015 | 2014 | |||||||||||||
| (in millions) | |||||||||||||||
| Net revenue | $ | 709 | $ | 662 | $ | 663 | 7% | — |
Diagnostics and genomics business revenue in 2016 increased 7 percent compared to 2015. Foreign currency movements for 2016 had an unfavorable currency impact of 1 percentage point on revenue growth when compared to the same period last year. Geographically, revenue grew 11 percent in the Americas with no currency impact. Revenue grew 1 percent in Europe with a 4 percentage point unfavorable currency impact. Revenue grew 6 percent in Japan with an 8 percentage point favorable currency impact. Revenue grew 17 percent in Asia Pacific excluding Japan with a 2 percentage point unfavorable currency impact. The performance in Americas and Europe were assisted by positive growth in sales in genomics (particularly target enrichment and arrays), strength in pathology business, continued demand in the nucleic acid solutions and good momentum in the companion diagnostic business. Growth in Asia Pacific excluding Japan reflected strong growth in China. Diagnostics and genomics business revenue in 2015 was flat compared to 2014, significantly impacted by currency.
The 7 percent revenue growth was due to positive growth from all businesses. This was led by continued growth momentum in the next generation sequencing (target enrichment portfolio) solution offering in the research and clinical research markets and an increase in the CGH products portfolio and good revenue performance in companion diagnostics business working with our pharmaceutical partners. Nucleic acid business saw continued market demand in the nucleic acid solutions business related to therapeutic oligo programs. The pathology business saw steady growth due to continued growth in our Omnis instrument placements and steady growth in the reagent revenues including traction in our PD-L1 assays. The end markets in diagnostics and clinical research remain strong and growing driven by an aging population and lifestyle. The positive local currency revenue growth in 2015 was also driven by demand in the nucleic acid solutions, good revenue performance in pathology and companion diagnostics businesses as well as next generation sequencing solution offering within the genomics business.
Looking forward, we are optimistic about our growth opportunities in the diagnostics markets and continue to invest in expanding and improving our applications and solutions portfolio. We remain positive about our growth in these markets, as adoption of our SureSelect and HaloPlex sequencing target enrichment solutions continue, and Omnis instruments and reagents, PD-L1 assays and SureFISH gain traction with our customers in clinical oncology applications. Market demand in the nucleic acid solutions business related to therapeutic oligo programs continues to be strong. Our nucleic acid business is expanding into a new site to accommodate future production needs. We will continue to invest in research and development, and seek to expand our position in developing countries and emerging markets.
Gross Margin and Operating Margin
The following table shows the diagnostics and genomics business's margins, expenses and income from operations for 2016 versus 2015, and 2015 versus 2014.
| Years Ended October 31, | 2016 over 2015 Change | 2015 over 2014 Change | ||||||||||
| 2016 | 2015 | 2014 | ||||||||||
| Total gross margin | 54.6 | % | 54.4 | % | 56.4 | % | — | (2) ppts | ||||
| Operating margin | 16.0 | % | 13.3 | % | 14.0 | % | 3 ppts | (1) ppt |
| (in millions) | |||||||||||||||
| Research and development | $ | 83 | $ | 78 | $ | 86 | 6% | (10)% | |||||||
| Selling, general and administrative | $ | 190 | $ | 195 | $ | 195 | (2)% | — | |||||||
| Income from operations | $ | 114 | $ | 88 | $ | 93 | 29% | (5)% |
Gross margin was flat in 2016 when compared to 2015. Favorable gross margins due to higher volumes and lower inventory charges were fully offset by unfavorable currency movements and wage increases. Gross margins decreased by 2 percentage points in 2015 compared to 2014. Gross margins reflected unfavorable currency movement impact, change in business mix, higher inventory charges, and wage increases.
Research and development expenses increased 6 percent in 2016 when compared to 2015 however, remained flat as a percentage of revenue. This reflected increase in wages and benefits and increased spending around the development of clinical applications and solutions were partially offset by favorable currency movements. Research and development expenses decreased 10 percent in 2015 when compared to 2014; however, remained flat as a percentage of revenue. The decline was mainly due to favorable currency movements and business improvement initiatives partially offset by wage increases.
Selling, general and administrative expenses decreased 2 percent in 2016 when compared to 2015, reflecting favorable currency movements, reduced expenses due to business improvement initiatives partially offset by wages and variable pay increases. Selling, general and administrative expenses were flat in 2015 compared to 2014, favorable currency movements, and business improvement initiatives and were offset by higher allocated infrastructure expenses following the Keysight separation and wage increases.
Operating margin increased 3 percentage points in 2016 when compared to 2015. The increase was due to higher volumes, lower inventory charges, better selling expenses partially offset by wage and benefits increases. Operating margins decreased by 1 percentage point in 2015 compared to 2014. The reduction was due to lower gross margins due to higher inventory charges and wage increases.
Income from Operations
Income from operations in 2016 increased by $26 million or 29 percent when compared to 2015 on a revenue increase of $47 million. The increase was due to higher volumes and reduced selling and general administration expenses. Income from operations in 2015 decreased by $5 million or 5 percent compared to 2014 on a revenue decrease of $1 million. The reduction was due to lower gross margins.
Agilent CrossLab
The Agilent CrossLab business spans the entire lab with its extensive consumables and services portfolio, which is designed to improve customer outcomes. The majority of the portfolio is vendor neutral, meaning Agilent can serve and supply customers regardless of their instrument purchase choices. Solutions range from chemistries and supplies to services and software helping to connect the entire lab. Key product categories in consumables include GC and LC columns, sample preparation products, custom chemistries, and a large selection of laboratory instrument supplies. Services include startup, operational, training and compliance support, as well as asset management and consultative services that help increase customer productivity. Custom service and consumable bundles are tailored to meet the specific application needs of various industries and to keep instruments fully operational and compliant with the respective industry requirements.
Net Revenue
| Years Ended October 31, | 2016 over 2015 Change | 2015 over 2014 Change | |||||||||||||
| 2016 | 2015 | 2014 | |||||||||||||
| (in millions) | |||||||||||||||
| Total net revenue | $ | 1,420 | $ | 1,330 | $ | 1,307 | 7% | 2% |
Agilent CrossLab business revenue in 2016 increased 7 percent when compared to 2015. Foreign currency movements for 2016 had an unfavorable impact of 2 percentage points when compared to 2015. Revenue growth in 2016 was led by increases in enterprise service contracts, LC small molecule columns, remarketed instruments, and bio-columns. Geographically, revenue grew 6 percent in the Americas with a 2 percentage point unfavorable currency impact. Revenue grew 3 percent in Europe with a 4 percentage point unfavorable currency impact. Revenue declined 4 percent in Japan with a 7 percentage point favorable currency impact due to macroeconomic conditions. Revenue grew 16 percent in Asia Pacific excluding Japan with a 4 percentage point unfavorable currency impact due to continued strength in China. Agilent CrossLab business revenue in 2015 increased 2 percent compared to 2014. Revenue growth in 2015 was led by strength in the overall aftermarket service agreement business, the remarketed instrument business, and our chemistries portfolio of LC columns and sample preparation products.
Agilent CrossLab business saw positive revenue growth in all the key end markets after accounting for the unfavorable currency movements in 2016. Revenue growth was led by the pharmaceutical and biotechnology market, as well as the food market. Revenue growth was slowest in the forensics market and the life science research market, but neither represented a large share of revenue in the Agilent CrossLab business. Agilent CrossLab business saw positive revenue growth in all the key end markets after accounting for the unfavorable currency impact in 2015 compared to 2014. Growth was led by the pharmaceutical and biotechnology markets. Revenue in chemical and emergy end markets were slower but still reported growth, adjusted for currency movements.
Looking forward, we expect continued strength in the pharmaceutical and biotechnology markets to drive growth in the near term. From a geographical stand point, we remain optimistic on the market growth and market penetration opportunities in China. Other factors for near term revenue growth will rely on upcoming product launches from our consumables pipeline, as well as on our investment in our laboratory enterprise offerings.
Gross Margin and Operating Margin
The following table shows the Agilent CrossLab business's margins, expenses and income from operations for 2016 versus 2015 and 2015 versus 2014.
| Years Ended October 31, | 2016 over 2015 Change | 2015 over 2014 Change | ||||||||||
| 2016 | 2015 | 2014 | ||||||||||
| Total gross margin | 49.4 | % | 49.6 | % | 48.5 | % | — | 1 ppt | ||||
| Operating margin | 22.3 | % | 22.5 | % | 23.0 | % | — | (1) ppt |
| (in millions) | |||||||||||||||
| Research and development | $ | 46 | $ | 46 | $ | 45 | — | 3% | |||||||
| Selling, general and administrative | $ | 339 | $ | 315 | $ | 287 | 7% | 10% | |||||||
| Income from operations | $ | 316 | $ | 299 | $ | 301 | 6% | (1)% |
Gross margin was flat in 2016 when compared to 2015, due to the higher sales volume and several margin improvement initiatives helping to offset the higher wages, unfavorable currency movements and a less favorable currency hedging results. Gross margin increased by 1 percentage point in 2015 compared to 2014, primarily due to the favorable currency hedging gains recognized in 2015, which were partially offset by higher logistic costs.
Research and development expenses was flat in 2016 when compared to 2015, due to wage increases being offset by moderate favorable currency movements. Research and development expenses increased 3 percent in 2015 when compared to 2014, due to higher project expenses and wage increases.
Selling, general and administrative expenses increased 7 percent in 2016 when compared to 2015, primarily due to higher orders driving higher field selling costs, wage increases and larger investments into marketing and the sales channel. Selling,
general and administrative expenses increased 10 percent in 2015 compared to 2014, due to the increase in allocated infrastructure costs following our separation of Keysight and wage increases.
Operating margin was flat in 2016 when compared to 2015, due to the higher sales volume helping to offset the higher wages, unfavorable currency movements less favorable currency hedging results, and increased selling, general and administrative expenses. Operating margin decreased by 1 percentage point in 2015 when compared to 2014, due to the increase in allocated infrastructure costs following our separation of Keysight, which were partially offset by the favorable currency hedging gains recognized in 2015.
Income from Operations
Income from operations in 2016 increased by $17 million or 6 percent when compared to 2015 on a revenue increase of $90 million, representing an incremental operating margin of 19 percent. This increase was driven primarily by volume offset by currency and higher selling, general and administrative expenses. Income from operations in 2015 decreased by $2 million or 1 percent compared to 2014 on a revenue increase of $23 million, representing an operating margin decrement. This decrease was primarily due to the favorable volume increase being offset by the increase in allocated infrastructure costs following our separation of Keysight.
Financial Condition
Liquidity and Capital Resources
Our financial position as of October 31, 2016 consisted of cash and cash equivalents of $2,289 million as compared to $2,003 million as of October 31, 2015.
As of October 31, 2016, approximately $2,181 million of our cash and cash equivalents is held outside of the U.S. in our foreign subsidiaries. Most of the amounts held outside of the U.S. could be repatriated to the U.S. but, under current law, would be subject to U.S. federal and state income taxes, less applicable foreign tax credits. Agilent has accrued for U.S. federal and state tax liabilities on the earnings of its foreign subsidiaries except when the earnings are considered indefinitely reinvested outside of the U.S. Repatriation could result in additional material U.S. federal and state income tax payments in future years. We utilize a variety of funding strategies in an effort to ensure that our worldwide cash is available in the locations in which it is needed.
We believe our cash and cash equivalents, cash generated from operations, and ability to access capital markets and credit lines will satisfy, for at least the next twelve months, our liquidity requirements, both globally and domestically, including the following: working capital needs, capital expenditures, business acquisitions, stock repurchases, cash dividends, contractual obligations, commitments, principal and interest payments on debt, and other liquidity requirements associated with our operations.
Net Cash Provided by Operating Activities
Net cash provided by operating activities was $793 million in 2016 as compared to $512 million provided in 2015 and $731 million provided in 2014. For the year ended October 31, 2014 net cash provided by operating activities included the cash provided by Keysight operating activities. We paid approximately $67 million of net taxes in 2016, as compared to $129 million in net taxes in 2015 and net taxes of $131 million in 2014. Income taxes, including those paid for the Keysight business, were paid by Agilent for the year ended October 31, 2014. The decrease in taxes paid for the year ended October 31, 2016 was primarily due to no taxes paid related to the separation and to a lesser extent due to some refund of taxes. Cash paid for income taxes for the year ended October 31, 2015 included tax payments related to the separation. Operating cash flows in 2014 were impacted by pre-separation costs and separation related taxes, the redemption of senior notes including payments related to accrued interest and the timing of the purchase of shares under the employee stock purchase plan. For the years ended October 31, 2016, 2015 and 2014 other assets and liabilities provided cash of $10 million and used cash of $249 million and $26 million, respectively. The increase in the usage of cash for the year ended October 31, 2015 in other assets and liabilities was largely the result of contributions to defined benefit plans, changes in interest and restructuring accruals, income tax liabilities and transaction tax assets and liabilities.
In 2016, the change in accounts receivable used cash of $33 million, $24 million in 2015, and $119 million in 2014. For the year ended October 31, 2014 the change in accounts receivable included $25 million of cash used by Keysight. Days' sales outstanding as of October 31, were 51 days in 2016, 53 days in 2015 and 49 days in 2014. The change in accounts payable used cash of $15 million in 2016, used cash of $26 million in 2015 and provided cash of $50 million in 2014. For the year ended October 31, 2014 the change in accounts payable included $32 million of cash provided by Keysight. Cash used in inventory was $7 million in 2016, in $24 million in 2015 and $99 million in 2014. For the years ended October 31, 2014 the change in inventory included $31 million of cash used by Keysight. Inventory days on-hand decreased to 92 days in 2016 compared to 97 days in 2015 and
106 days in 2014.
We contributed zero, $15 million and $30 million to our U.S. defined benefit plans in 2016, 2015 and 2014, respectively. For the year ended October 31, 2014 we contributed $15 million to our U.S. defined benefit plans on behalf of Keysight. We contributed $24 million, $25 million and $72 million to our non-U.S. defined benefit plans in 2016, 2015 and 2014, respectively. For the year ended October 31, 2014 we contributed $41 million to our non-U.S. defined benefit plans on behalf of Keysight. We contributed less than $1 million in both 2016 and 2015 and $1 million in 2014 to our U.S. post-retirement benefit plans. Our non-U.S. defined benefit plans are generally funded ratably throughout the year. Total contributions in 2016 were $24 million or 40 percent less than 2015. Our annual contributions are highly dependent on the relative performance of our assets versus our projected liabilities, among other factors. We expect to contribute approximately $26 million to our U.S. and $20 million non-U.S. defined benefit plans and nothing to our U.S. post-retirement benefit plans during 2017.
Net Cash Used in Investing Activities
Net cash used in investing activities in 2016 was $238 million and in 2015 was $400 million as compared to net cash used of $230 million in 2014. For the year ended October 31, 2014 cash used in investing activities included $82 million of cash used by Keysight.
Investments in property, plant and equipment were $139 million in 2016, $98 million in 2015 and $205 million in 2014. For the year ended October 31, 2014 investments in plant and equipment included $70 million related to Keysight. Proceeds from sale of property, plant and equipment were zero in 2016, $12 million in 2015 and $14 million in 2014. In 2016 we invested $261 million in acquisitions of businesses and intangible assets, net of cash acquired compared to $74 million in 2015 and $13 million in 2014. In 2016 we made a payment of $80 million for the purchase of a cost method investment in Lasergen compared to zero outlay in 2015 and 2014. We made a loan to our equity method investment of $3 million in 2016 and zero in both 2015 and 2014. Change in restricted cash and cash equivalents was $245 million inflow in 2016, $240 million outflow in 2015 (both changes related to our Seahorse Biosciences acquisition) and $4 million in 2014, respectively.
Net Cash Used in Financing Activities
Net cash used in financing activities in 2016 was $268 million compared to $1,089 million in 2015 and $117 million in 2014, respectively. The increase in cash used in 2015 when compared to 2014 was largely due to the net cash transferred to Keysight.
Treasury stock repurchases
On November 22, 2013 we announced that our board of directors had authorized a share repurchase program. The existing program is designed to reduce or eliminate dilution resulting from issuance of stock under the company's employee equity incentive programs to target maintaining a weighted average share count of approximately 335 million diluted shares. For the years ended October 31, 2016, 2015 and 2014 we repurchased 2.4 million shares for $98 million, 6 million shares for $267 million and 4 million shares for $200 million, respectively. All such shares and related costs are held as treasury stock and accounted for using the cost method.
On May 28, 2015 we announced that our board of directors had approved a new share repurchase program (the "2015 repurchase program"). The 2015 share repurchase program authorizes the purchase of up to $1.14 billion of our common stock through and including November 1, 2018. The 2015 repurchase program does not require the company to acquire a specific number of shares and may be suspended or discontinued at any time. During the year ended October 31, 2016, upon the completion of our previous repurchase program, we repurchased approximately 8.3 million shares for $336 million under this authorization. All such shares and related costs are held as treasury stock and accounted for using the cost method. As of October 31, 2016, we had remaining authorization to repurchase up to $804 million of our common stock under this program.
Dividends
For the years ended October 31, 2016, 2015 and 2014 cash dividends of $150 million, $133 million and $176 million were paid on the company's outstanding common stock, respectively. On November 16, 2016, we declared a quarterly dividend of $0.132 per share of common stock, or approximately $43 million which will be paid on January 25, 2017 to shareholders of record as of the close of business on January 3, 2017. The timing and amounts of any future dividends are subject to determination and approval by our board of directors.
Credit Facility
On September 15, 2014, Agilent entered into a credit agreement with a financial institution which provides for a $400 million five-year unsecured credit facility that will expire on September 15, 2019. On June 9, 2015, the commitments under the existing credit facility were increased by $300 million so that the aggregate commitments under the facility now total $700 million. For the year ended October 31, 2016, we borrowed $255 million and repaid $255 million by October 31, 2016. As of October 31, 2016, the company had no borrowings outstanding under the facility. We were in compliance with the covenants for the credit facility during the years ended October 31, 2016 and 2015. As of December 20, 2016, the company had borrowings of $65 million outstanding under this credit facility and may borrow more during fiscal year 2017.
Long-term debt
In October 2007, the company issued an aggregate principal amount of $600 million in senior notes ("2017 senior notes"). The 2017 senior notes were issued at 99.60% of their principal amount. The notes will mature on November 1, 2017, and bear interest at a fixed rate of 6.50% per annum. The interest is payable semi-annually on May 1st and November 1st of each year and payments commenced on May 1, 2008.
On November 25, 2008, we terminated two interest rate swap contracts associated with our 2017 senior notes that represented the notional amount of $400 million. The asset value, including interest receivable, upon termination was approximately $43 million and the amount to be amortized at October 31, 2016 was $1 million. The gain is being deferred and amortized to interest expense over the remaining life of the 2017 senior notes.
In July 2010, the company issued an aggregate principal amount of $500 million in senior notes ("2020 senior notes"). The 2020 senior notes were issued at 99.54% of their principal amount. The notes will mature on July 15, 2020, and bear interest at a fixed rate of 5.00% per annum. The interest is payable semi-annually on January 15th and July 15th of each year, payments commenced on January 15, 2011.
On August 9, 2011, we terminated our interest rate swap contracts related to our 2020 senior notes that represented the notional amount of $500 million. The asset value, including interest receivable, upon termination for these contracts was approximately $34 million and the amount to be amortized at October 31, 2016 was $15 million. The gain is being deferred and amortized to interest expense over the remaining life of the 2020 senior notes.
In September 2012, the company issued an aggregate principal amount of $400 million in senior notes ("2022 senior notes"). The 2022 senior notes were issued at 99.80% of their principal amount. The notes will mature on October 1, 2022, and bear interest at a fixed rate of 3.20% per annum. The interest is payable semi-annually on April 1st and October 1st of each year, payments commenced on April 1, 2013.
In June 2013, the company issued aggregate principal amount of $600 million in senior notes ("2023 senior notes"). The 2023 senior notes were issued at 99.544% of their principal amount. The notes will mature on July 15, 2023 and bear interest at a fixed rate of 3.875% per annum. The interest is payable semi-annually on January 15th and July 15th of each year and payments will commence January 15, 2014.
On September 15, 2016, the company issued aggregate principal amount of $300 million in senior notes ("2026 senior notes"). The 2026 senior notes were issued at 99.624%% of their principal amount. The notes will mature on September 22, 2026 and bear interest at a fixed rate of 3.050% per annum. The interest is payable semi-annually on March 22nd and September 22nd of each year and payments will commence March 22, 2017.
In 2016, we paid approximately $37 million, of our mortgage debt, secured on buildings in Denmark, to a Danish financial institution. The gain recognized upon early payment was not material. No balance exists on this debt as of October 31. 2016.
Off Balance Sheet Arrangements and Other
We have contractual commitments for non-cancelable operating leases. See Note 15, "Commitments and Contingencies", to our consolidated financial statements for further information on our non-cancelable operating leases.
Our liquidity is affected by many factors, some of which are based on normal ongoing operations of our business and some of which arise from fluctuations related to global economics and markets. Our cash balances are generated and held in many locations throughout the world. Local government regulations may restrict our ability to move cash balances to meet cash needs under certain circumstances. We do not currently expect such regulations and restrictions to impact our ability to pay vendors and conduct operations throughout our global organization.
Contractual Commitments
Our cash flows from operations are dependent on a number of factors, including fluctuations in our operating results, accounts receivable collections, inventory management, and the timing of tax and other payments. As a result, the impact of contractual obligations on our liquidity and capital resources in future periods should be analyzed in conjunction with such factors.
The following table summarizes our total contractual obligations at October 31, 2016 for Agilent operations and excludes amounts recorded in our consolidated balance sheet (in millions):
| Less than one year | One to three years | Three to five years | More than five years | ||||||||||||
| Operating leases | $ | 38 | $ | 60 | $ | 22 | $ | 26 | |||||||
| Commitments to contract manufacturers and suppliers | 359 | 3 | — | — | |||||||||||
| Other purchase commitments | 62 | — | — | — | |||||||||||
| Retirement plans | 45 | — | — | — | |||||||||||
| Total | $ | 504 | $ | 63 | $ | 22 | $ | 26 |
Operating leases. Commitments under operating leases relate primarily to leasehold property, see Note 15, "Commitments and Contingencies".
Commitments to contract manufacturers and suppliers. We purchase components from a variety of suppliers and use several contract manufacturers to provide manufacturing services for our products. During the normal course of business, we issue purchase orders with estimates of our requirements several months ahead of the delivery dates. The above amounts represent the commitments under the open purchase orders with our suppliers that have not yet been received. However, our agreements with these suppliers usually provide us the option to cancel, reschedule, and adjust our requirements based on our business needs prior to firm orders being placed. We expect to fulfill most of our purchase commitments for inventory within one year.
In addition to the above mentioned commitments to contract manufacturers and suppliers, in the past we recorded a liability for firm, non-cancelable and unconditional purchase commitments for quantities in excess of our future demand forecasts consistent with our policy relating to excess inventory. As of October 31, 2016, the liability for our firm, non-cancelable and unconditional purchase commitments was less than $1 million compared to $5 million, as of October 31, 2015 and $10 million as of October 31, 2014. These amounts are included in other accrued liabilities in our consolidated balance sheet.
Other purchase commitments. We have categorized "other purchase commitments" related to contracts with professional services suppliers. Typically, we can cancel contracts without penalties. For those contracts that are not cancelable without penalties, we are disclosing the termination fees and costs or commitments for continued spending that we are obligated to pay to a supplier under each contact's termination period before such contract can be cancelled. Our contractual obligations with these suppliers under "other purchase commitments" were approximately $62 million within the next year.
Retirement Plans. Commitments under the retirement plans relate to expected contributions to be made to our U.S. and non-U.S. defined benefit plans and to our post-retirement medical plans for the next year only. Contributions after next year are impractical to estimate.
We had no material off-balance sheet arrangements as of October 31, 2016 or October 31, 2015.
On Balance Sheet Arrangements
The following table summarizes our total contractual obligations at October 31, 2016 related to our long-term debt and interest expense (in millions):
| Less than one year | One to three years | Three to five years | More than five years | ||||||||||||
| Senior notes | $ | — | $ | 100 | $ | 500 | $ | 1,300 | |||||||
| Interest expense | 77 | 144 | 116 | 106 | |||||||||||
| Total | $ | 77 | $ | 244 | $ | 616 | $ | 1,406 |
Other long-term liabilities include $190 million and $227 million of liabilities for uncertain tax positions as of October 31, 2016 and October 31, 2015, respectively. We are unable to accurately predict when these amounts will be realized or released. However, it is reasonably possible that there could be significant changes to our unrecognized tax benefits in the next twelve months due to either the expiration of a statute of limitations or a tax audit settlement.
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